When I began fundraising for CircleUp six years ago, I encountered many investors whose eyes would glaze over when I mentioned “consumer.”

These investors would fidget uncomfortably or drop their gaze when I explained that our platform would only provide capital to small CPG companies. I would often hear the skeptical comments, such as, “an energy bar company can’t really get that big,” “baby food isn’t scalable,” and my personal favorite, “I can’t name a single consumer company” (real quote from a VC).

Alongside blockchain and AI, “technology-enabled” CPG startups are now a bona fide trend for Silicon Valley VCs. The uptick in tech VC dollars going to the CPG market is partly because tech investing is brutally competitive and saturated, and largely because these VCs are awakening to the strong historical returns in CPG, especially with the trend leaning towards small brands stealing market share.

Consumer is a massive market – about 3x the size of tech, as seen below.

Despite the size of the market, the early-stage has historically been underserved by investors due to market inefficiencies like the geographic dispersion of brands and a lack of structured information sources (i.e. there is no Silicon Valley for consumer, and certainly no Crunchbase equivalents – yet). In theory, the recent trend of VC dollars going to fill a capital gap in CPG should result in a win-win. In effect, many of the tech VC investments into consumer are misguided, and sometimes even harmful. Investors may lose money, but entrepreneurs can lose companies they’ve spent lifetimes building.

There are a few things that VC investors should keep in mind to ensure they invest in a way that benefits both them and the entrepreneurs they work with.

One company won’t rule its market

The heart of the problem with tech investors in CPG is that they operate under the assumption that one CPG player can rule its market. They believe this because in tech, it’s largely true. When you look at Uber and Airbnb, it is likely that one or two players could own 70% of their respective markets. Holding this assumption in the CPG space, however, in fundamentally flawed.

There has been a secular shift over the past 5-10 years where people now favor unique, targeted products catering to personal preferences. Today, even the act of selecting a beer or hand lotion is a form of self-expression. The result is a fragmentation with many brands that are more targeted in their offering. Many of these products are inherently smaller in scale and never intend to be mass market—yet do frequently get gobbled up by public consumer conglomerates. The M&A in consumer and retail was over $300 billion in 2017 according to PWC, vs. $170b for tech.

While the market grows more and more fragmented with small to mid-sized brands offering diversified products, we’re moving far away from the notion that one condiments or baby products brand can own 70% of its category.

Too-high valuations and large raises are harmful, not encouraging

Relatedly, putting too high a valuation on a CPG company and theorizing it could rule its market is counterproductive and unrealistic. It pushes the entrepreneur to unnatural and harmful tactics to meet this valuation, or to eventually fundraise again at a lower valuation – or at a higher valuation from whatever out-of-tune investor they can find to do – then seriously struggle to exit. Some of the spiraling is obvious, including inflated marketing campaigns that force growth, often long before the product is ready, and some are less obvious, including inflated numbers in investor decks behind the scenes.

Ask anyone knowledgeable in consumer about why Unilever bought Seventh Generation instead of the similar, but far more trendy Honest Company. It’s largely because of valuation. By every account, the VCs involved in Honest Company put a valuation in previous rounds that made no sense relative to core metrics. Consumer companies shouldn’t raise $30m in equity to grow, let alone $300m. The result: Honest Company couldn’t get the exit it wanted, had to cut costs, and reportedly faced tremendous unrest among employees who were upset about the direction the company was heading.

Ultimately, CPG brands don’t need that much money to grow. Capital efficiency is one of the beauties of CPG. Consumer companies can typically raise $4-8m to get to $10m in revenue, where they are often profitable. Tech companies typically raise $40-50m to get to the same revenue range, and often fail to make a profit even at that point. SkinnyPop, RXBar, Sir Kensington’s and Native Deodorant are great examples of the lean operations characteristic of CPG.

A great brand isn’t as simple as a D2C model and a sleek website

In the past year I’ve had 10-20 tech VCs call me and say some variation on this: “we want to get into consumer, but it has to be tech enabled, because we told our LPs we’d invest in tech companies.” This over focus on D2C leads VCs to put too much money into the company at too high a valuation.

D2C is a channel. Just like the convenience store channel (i.e. 7/11), club (Costco), mass (Walmart) and grocery (Safeway). Like these other channels, DTC has pros and cons. It is not a Holy Grail. Too often, we see inexperienced VCs talk about D2C as “lower cost” when in reality the average D2C brand raises 10-30x the amount of brands in the offline world with massive overvaluations. Tell a D2C entrepreneur that their channel is cheaper than offline, and she will quickly explain to you that the Customer Acquisition Costs in the past 3-5 years have made that no longer true. If D2C is better margins, why did Bonobos raise $127m, Dollar Shave Club raise $164m and Casper raise $240m?

D2C is a channel, but it does not change the underlying fundamentals of what makes a successful CPG company. Those fundamentals, aside from margins and team, are brand, distribution and product differentiation. Product differentiation in consumer is necessary, but not sufficient, for success. The product must be unique relative to other offerings, and in a way that matters to people. Kind Bar looked like real food relative to Clif Bar, 5 Hour Energy was the only energy drink fit for on-the-go, and Halo Top gave you permission to eat a whole pint in one sitting. If those sound silly, they are all billions-dollar companies that each raised far less than the typical tech company, thus with less dilution.

The way forward

Consumer is an amazing market with massive depth and presents a wonderful opportunity for investors to help build the dreams of entrepreneurs with them. If VCs truly want to succeed in this market, they need to take the time to understand the fundamentals of consumer investing. I hope that more investors catch on to this so that wonderful consumer entrepreneurs can continue to get the capital and resources they need to thrive.